Pavlovich Instruments Inc., a maker of precision telescopes, expects to report pretax income of $430,000 this year. The company’s financial manager is considering the timing of a purchase of new computerized lens grinders. The grinders will have an installed cost of $80,000 and a cost recovery period of 5 years. They will be depreciated using the MACRS schedule.

a. If the firm purchases the grinders before year’s end, what depreciation expense will it be able to claim this year? (Use Table 4.2.)

b. If the firm reduces its reported income by the amount of the depreciation expense calculated in part a, what tax savings will result?

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Tax case Definition Tax treatment Tax consequence 40% of gain is a tax liability. Gain on the Portion of the sale All gains above book value are taxed as ordinary income. sale of asset price that is greater than book value Loss on the Amount by which sale price is less than book value If the asset is depreciable and used in business, then loss is deducted from ordinary income. 40% of loss is a sale of asset tax savings. 40% of loss is a tax savings. If the asset is not depreciable or is not used in business, then loss is deductible only against capital gains.